SOUTHEASTERN MUTUAL INSURANCE COMPANY FINANCIAL STATEMENTS
INDEX Page INDEPENDENT AUDITORS' REPORT 1-2 FINANCIAL STATEMENTS Statement 1 - Financial Position 3 Statement 2 - Changes in Equity 4 Statement 3 - Comprehensive Income 5 Statement 4 - Cash Flows 6 Operating Expenses - Schedule 1 7 Summary of Significant Accounting Policies and Explanatory Information 8-31
AC Stevenson & Partners PC Inc. 567 Coverdale Road Riverview, N.B., Canada E1B 3K7 506-387-4044 Tel 506-387-7270 Fax sp@partnersnb.com INDEPENDENT AUDITORS' REPORT To the policyholders of Southeastern Mutual Insurance Company: Report on the Financial Statements We have audited the accompanying statement of financial position of Southeastern Mutual Insurance Company as at December 31, 2013 and the statements of changes in equity, comprehensive income and cash flows for the year then ended, and a summary of significant accounting policies and other explanatory information. Management's Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. Auditors' Responsibility Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. 1
INDEPENDENT AUDITORS' REPORT (CONTINUED) Opinion In our opinion, the financial statements present fairly, in all material respects, the financial position of Southeastern Mutual Insurance Company as at December 31, 2013, and its financial performance and cash flows for the year then ended in accordance with International Financial Reporting Standards. Other Matters In accordance with section 78 of the Insurance Act of New Brunswick, we confirm that, within the scope of materiality we have verified cash, bank balance and securities, we have checked the reserve of unearned premiums and it is calculated as required by the Insurance Act, we have examined the reserve for unpaid claims and in our opinion it is adequate, we have verified the balances owing by agents and other insurers, we have verified that the statement of financial position does not include as assets items prohibited by the Insurance Act, and that all transactions of the company that have come within our notice have been within its power. Riverview, NB February 20, 2014 Chartered Accountants 2
STATEMENT OF FINANCIAL POSITION Statement 1 ASSETS Cash and cash equivalents $ 800,321 $ 661,498 Accrued interest receivable 45,144 37,349 Premiums receivable 1,325,045 1,232,303 Reinsurance receivable 2,236 - Reserve for reinsurance on policy claims and liabilities (Note 4) 123,590 224,958 Deferred premium acquisition costs (Note 4) 620,291 613,338 Investments (Note 5) 11,393,440 10,463,512 Property and equipment (Note 7) 599,850 635,381 Investment in associate (Note 6) 4,208,337 4,264,527 Intangible assets (Note 7) 28,313 26,711 Investment property (Note 8) 143,788 137,530 LIABILITIES $ 19,290,355 $ 18,297,107 Accounts payable and accrued liabilities (Note 9) $ 462,968 $ 441,631 Reserve for policy claims and liabilities (Note 4) 680,477 688,250 Income taxes payable (Note 10) 188,432 87,719 Unearned premiums (Note 4) 3,558,704 3,439,899 Agents' future retirement compensation (Note 11) 96,226 91,928 4,986,807 4,749,427 Contingent Liabilities (Note 14) EQUITY General Reserve - Statement 2 14,150,934 13,446,876 Accumulated other comprehensive income - Statement 2 152,614 100,804 14,303,548 13,547,680 APPROVED ON BEHALF OF THE BOARD: $ 19,290,355 $ 18,297,107 Donald Howe - Chairmain Jack Low Chair of Audit Finance Committee The accompanying summary of significant accounting policies and other explanatory information are an integral part of these financial statements. 3
STATEMENT OF CHANGES IN EQUITY Statement 2 FOR THE YEAR ENDED General Reserve (Note 15) General Reserve, beginning of year, as previously stated 13,496,458 12,297,441 Prior period adjustment (Note 18) (49,582) (49,511) General Reserve, beginning of year, as restated $ 13,446,876 $ 12,247,930 Net income for the year - Statement 3 704,058 1,198,946 General Reserve, end of year - Statement 1 $ 14,150,934 $ 13,446,876 Accumulated Other Comprehensive Income Accumulated other comprehensive income, beginning of year $ 100,804 $ 79,098 Total other comprehensive income - Statement 3 51,810 21,706 Accumulated other comprehensive income, end of year - Statement 1 $ 152,614 $ 100,804 The accompanying summary of significant accounting policies and other explanatory information are an integral part of these financial statements. 4
STATEMENT OF COMPREHENSIVE INCOME Statement 3 FOR THE YEAR ENDED Premiums written $ 6,674,741 $ 6,446,046 Less: Quota share recovery - 87,384 Reinsurance premiums (1,179,741) (1,184,101) Change in unearned premiums (Note 4) (118,805) (241,965) Net premiums earned 5,376,195 5,107,364 Service charge revenue 96,556 86,744 Net underwriting revenue 5,472,751 5,194,108 Losses Claims and adjusting expenses incurred 2,297,259 2,063,563 Reinsurance (recoveries) charges (145,429) 21,725 Net claims incurred 2,151,830 2,085,288 3,320,921 3,108,820 Premium acquisition expenses Commissions expense 1,017,394 986,061 Change in commissions earned (552) (547) Net commissions 1,016,842 985,514 Premium tax 196,282 187,037 Fire Marshall's tax 47,124 44,451 Advocacy and Insurance Act assessment 7,230 8,156 1,267,478 1,225,158 Operating expenses - Schedule 1 1,880,537 1,645,497 3,148,015 2,870,655 Underwriting profit 172,906 238,165 Investment and other income Equity income (loss) from associate (108,000) 609,417 Investment income (Note 13) 844,152 453,364 736,152 1,062,781 Income before income taxes 909,058 1,300,946 Provision for income taxes (Note 10) (205,000) (102,000) Net income for the year - Statement 2 704,058 1,198,946 Other comprehensive income: Share of other comprehensive income from associate - Statement 2 51,810 21,706 Comprehensive income $ 755,868 $ 1,220,652 The accompanying summary of significant accounting policies and other explanatory information are an integral part of these financial statements. 5
STATEMENT OF CASH FLOWS Statement 4 FOR THE YEAR ENDED Cash flows from operating activities: Net income for the year - Statement 3 $ 704,058 $ 1,198,946 Items not requiring an outlay of cash: Depreciation and amortization 101,259 119,630 Loss (gain) on disposal of investments (116,547) 255,408 Equity loss (income) from associate 108,000 (609,417) Amortization of bond premiums 36,188 49,431 Gain on disposal of property and equipment (315) (3,832) Change in fair value through profit or loss financial instruments (Note 17) (430,568) (428,026) 402,075 582,140 Changes in non-cash working capital balances: Accrued interest receivable (7,796) 26,441 Premiums receivable (92,742) (104,659) Reinsurance receivable 99,132 78,784 Deferred premium acquisition costs (6,953) (6,757) Accounts payable and accrued liabilities 21,337 54,890 Claims payable (7,773) (336,924) Income taxes payable/recoverable 100,713 119,792 Agents' future retirement compensation 4,299 (17,446) Unearned premiums 118,805 241,965 Cash flows from operating activities 631,097 638,226 Cash flows from investing activities: Additions to property, equipment and intangibles (61,844) (45,093) Proceeds on disposal of property and equipment 315 10,620 Purchase of investment property (11,744) (139,979) Investments matured/sold 1,025,045 1,301,913 Proceeds from sale of equity investments 1,195,349 2,164,607 Purchase of equity and other investments (2,639,395) (3,493,457) Cash flows used for investing activities (492,274) (201,389) Increase in cash and cash equivalents 138,823 436,837 Cash and cash equivalents, beginning of year 661,498 224,661 Cash and cash equivalents, end of year - Statement 1 $ 800,321 $ 661,498 See supplementary cash flow information Interest paid $ - $ 1,096 Interest received $ 278,292 $ 324,957 Income taxes paid $ 104,456 $ 3,616 Income taxes received $ - $ 21,406 The accompanying summary of significant accounting policies and other explanatory information are an integral part of these financial statements. 6
SCHEDULE OF OPERATING EXPENSES Schedule 1 FOR THE YEAR ENDED Advertising and donations $ 111,041 $ 71,337 Agents' benefits 118,875 111,013 Association fees and memberships 24,052 24,024 Building occupancy costs 81,804 79,283 Computer operations 137,288 122,129 Conventions and meetings 39,772 38,656 Depreciation and amortization 101,259 119,630 Directors' remuneration 139,065 112,728 Insurance and bonding 29,359 24,245 Interest and bank charges 35,225 33,876 Loss prevention 110,984 156,983 Office, postage and stationery 118,541 89,800 Professional fees 143,290 46,672 Salaries and employee benefits 553,063 485,362 Scholarship 6,000 6,000 Telephone 33,290 33,664 Training and education 22,987 9,594 Travel 74,642 80,501 $ 1,880,537 $ 1,645,497 The accompanying summary of significant accounting policies and other explanatory information are an integral part of these financial statements. 7
General information and statement of compliance with International Financial Reporting Standards Southeastern Mutual Insurance Company is incorporated under the laws of New Brunswick and is subject to the Insurance Act of New Brunswick. The company is a mutual insurance company which offers fire, extended peril and liability coverage to selected real property owners in the southeastern region of the province. The financial statements of the company have been prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB). 1. Adoption of new and revised standards and interpretations At the date of authorization of these financial statements, the IASB and IFRS Interpretations committee (IFRIC) has issued the following new and revised standards, amendments and interpretations which are not yet effective during period covered by these financial statements. IFRS 9 - Financial Instruments (January 1, 2015) The company anticipates that the application of these standards, amendments and interpretations will have no material impact on the results and financial positions of the company. 2. Summary of significant accounting policies The accompanying financial statements have been prepared in accordance with International Financial Reporting Standards and in accordance with the regulations of the Superintendent of Insurance of New Brunswick. The financial statements have been prepared on the historical cost basis, except for the revaluation of financial instruments and deemed cost of land and building. The significant accounting policies adopted by the company are set out below. In accordance with IFRS 4 Insurance Contracts, the company has applied previous Canadian generally accepted accounting principles (GAAP) accounting policies modified as appropriate to comply with the IFRS framework. Previous Canadian GAAP accounting policies will continue to be applied for the company's insurance contracts until such time as the current project by IASB for insurance contracts is completed and subsequently adopted. (a) Financial instruments All financial instruments are classified as either fair value through profit or loss (FVTPL), available-for-sale, held-to-maturity, loans and receivables, or other liabilities. FVTPL and available-for-sale financial instruments are revalued to their fair value as of the financial statement reporting date. FVTPL financial instruments are recognized through the statement of operations and available-for-sale financial instruments are recognized through other comprehensive income until the instrument is derecognized or impaired. Held-to-maturity, loans and receivables, and other liabilities are measured at amortized cost. Transactions costs are included in the carrying value of the financial instruments. For information on the classification of each financial instrument of the company see Note 17. 8
2. Summary of significant accounting policies (continued) (a) Financial instruments (continued) Available-for-sale financial assets are assessed for indicators of impairment at each reporting period date. They are impaired where there is objective evidence that, as a result of one or more events that occurred after the initial recognition of the financial asset, the estimated future cash flows of the investment have been impacted. A significant or prolonged decline in fair value of an available-for-sale financial asset below its cost is considered to be objective evidence of impairment. For certain categories of financial assets, such as receivables, assets that are assessed not to be impaired individually are subsequently assessed for impairment on a collective basis. The carrying amount of the financial assets is reduced by the impairment loss directly for all financial assets and the loss is recognized in net income (loss) for the year. In respect of available-for-sale financial instruments, impairment losses previously recognized through net income (loss) are not reversed through net income (loss) for the year. Any increase in fair value subsequent to an impairment loss is recognized directly in comprehensive income (loss) for the year. Investments Equities are classified as FVTPL financial instruments. They are carried at fair value based on bid prices published in financial newspapers or bid quotations received from securities dealers. Bonds and debentures are classified as held to maturity financial instruments. They are measured at amortized cost. Any premium or discounts on bond acquisition is amortized, and any specific investment provisions flow through net earnings. Investment income Realized gains and losses arising from the sale of investments are the difference between the proceeds received, net of transaction costs, and its original cost or amortized cost as appropriate, using the average cost basis. Interest income is recorded on the accrual basis and dividends are recorded when the rights to receive payment have been established. Bond premiums and discounts are amortized over the life of the bond. Unrealized gains and losses Unrealized gains or losses on the Investments represents the difference between the carrying value at the year end and the carrying value at the previous year end or purchase value during the year, less the reversal of previously recognized unrealized gains and losses in respect of disposals during the year. 9
2. Summary of significant accounting policies (continued) (b) Insurance contracts Deferred premium acquisition costs Deferred premium acquisition costs consist of agents' commissions and premium taxes related to unearned premiums. These costs, to the extent that they are considered recoverable, are deferred and written off to income over the same periods that the related premiums are earned. In determining the amount recoverable consideration is given to claims and related expenses expected to be incurred as the premiums are earned. Reserves for policy and claims liabilities Reserves for policy and claims liabilities includes claims and adjustment expenses which represent the estimated amounts required to settle all outstanding and unreported claims incurred to the end of the fiscal year. The valuation of the claims liabilities are determined on a non-discounted basis. Earned/unearned premium revenue Premium revenue is recognized on a daily pro rata basis over the terms of the insurance policies. Unearned premiums represent the portion of premiums written which are applicable to the unexpired terms of the policy in force. Premiums ceded Premiums ceded and reinsurance recoveries on losses incurred are recorded as reductions of the respective income and expense accounts. Expected reinsurance recoveries on unpaid claims are recognized as assets at the same time and using principles consistent with the company's method for establishing the related liability. (c) Cash and cash equivalents Cash and cash equivalents are comprised of cash on hand, balances with banks and highly liquid temporary investments which are readily convertible into cash and which are subject to insignificant risk of changes in value. (d) Property and equipment Property and equipment are recorded at cost or deemed cost less accumulated amortization and any recognized impairment loss. Depreciation is provided annually on a straight-line basis at rates calculated to write-off the cost or valuation of the property and equipment over their estimated useful lives using the following rates: Building 2.5 % to 10% Furniture and fixtures 10 % Computers 33 % Vehicles 20 % Signs 20 % 10
2. Summary of significant accounting policies (continued) (e) Intangible assets Intangible assets consist of computer software, which are not integral to the operation of computer hardware owned by the company. Software is initially recorded at cost and subsequently measured at cost less accumulated amortization and accumulated impairment losses. Software is amortized on a straight-line basis over its estimated useful life of 3 years. (f) Investment property The company s investment property consists of land and building held to earn rental income. Investment property is initially recorded at cost or deemed cost and subsequently measured at cost less accumulated depreciation and accumulated impairment losses. Land is not depreciated. Buildings are depreciated on a straight-line basis over their estimated useful life of 40 years. Rent receivable is recognized in net income/loss and is spread on a straight-line basis over the period of the lease. Where an incentive, such as a rent free period is given to a tenant, the carrying value of the investment property excludes any amount reported as a separate asset. (g) Impairment of tangible assets At the end of each reporting period, the company reviews the carrying amounts of its tangible assets to determine whether there is any indication that those assets have suffered impairment loss. If any such indication exists, the recoverable amount of the asset is estimated in order to determine the extent of impairment loss (if any). Where the asset does not generate cash flows that are independent from other assets, the company estimates the recoverable amount of the asset's useful life. The recoverable amount is the higher of fair value less costs to sell and value in use. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset which the estimates of future cash flows have not been adjusted. If the recoverable amount of an asset is estimated to be less than its carrying amount, the carrying amount of the asset is reduced to its recoverable amount. An impairment loss is recognized as an expense immediately. Where an impairment loss subsequently reverses, the carrying amount of the asset is increased to the revised estimate of its recoverable amount, but so that the increase in carrying amount does not exceed the carrying amount that would have been determined had no impairment loss been recognized for the asset in prior years. A reversal of an impairment loss is recognized as income immediately. 11
2. Summary of significant accounting policies (continued) (h) Income taxes The tax expense represents the sum of current income tax payable and deferred income tax. The income tax currently payable is based on taxable income for the year. Taxable income differs from net income (loss) as reported in the statement of operations because it excludes items of income or expense that are taxable or deductible in other years and it further excludes items that are never taxable or deductible. The company's liability for current income tax is calculated using income tax rates effective at the statement of financial position date. Deferred income tax is the tax expected to be payable or recoverable on differences between the carrying amounts of assets and liabilities in the financial statement and the corresponding income tax bases used in the computation of taxable income. Deferred tax is accounted for as an asset or liability on the statement of financial position. Deferred income tax liabilities are generally recognized for all taxable temporary differences and deferred income tax assets are recognized to the extent that it is probable that taxable income will be available against which deductible temporary differences can be utilized. The carrying amount of deferred income tax assets is reviewed at each statement of financial position date and reduced to the extent that it is no longer probable that sufficient taxable income will be available to allow all or part of the asset to be recovered. Deferred income tax is calculated at the tax rates that have been enacted or substantially enacted at the end of the reporting period. Deferred tax is charged or credited to the statement of operations, except when it relates to items charged or credited directly to equity, in which case the deferred income tax is charged or credited in equity. Deferred income tax assets and liabilities are offset when there is a legally enforceable right of offset of current income tax assets and liabilities and when the company intends to settle its current income tax assets and liabilities on a net basis. (i) Comprehensive income (loss) Comprehensive income includes the change in the company's net assets that result from transactions, events and circumstances from sources other than the company's equity and includes items that would not normally be included in net income (loss), such as unrealized gains and losses on available-for-sale financial instruments. (j) Product classification The company's product consists of property and liability insurance and is classified, for accounting purposes, as an insurance contract. A contract that is classified as an insurance contract remains an insurance contract until all rights and obligations are extinguished or expire. Insurance contracts are those contracts that transfer significant insurance risk, if and only if, an insured event could cause an insurer to make significant additional benefits in any scenario, excluding scenarios that lack commercial substance. Such contracts may also transfer financial risk. 12
3. Critical accounting judgments and key sources of estimation uncertainty In the application of the company's accounting policies, which are described in Note 2, management is required to make judgments, estimates and assumptions about the carrying amounts of assets and liabilities that are not readily available from other sources. The estimates and associated assumptions are based on historical experience and other factors that are considered to be relevant. Actual results may differ from these estimates. The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimate is revised if the revision affects only that period, or in a period of the revision and future periods if the revision affects both current and future periods. (a) Critical judgments in applying the company's accounting policies Management has not made any critical judgments apart from those involving estimations (which are dealt with separately below) in the process of applying the company's accounting policies that have significant effect on the amounts recognized in these financial statements. (b) Key sources of estimation uncertainty The key assumptions concerning the future, and other key sources of estimation uncertainty at the reporting date, that have significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year, are discussed below. Valuation of reserves for policy and claims liabilities Determining the reserve for policy and claims liabilities involves an assessment of the future development of the claims. The process takes into account the consistency of the company's claims handling procedures, the amount of information available, the characteristics of the line of business from which the claim arises, and the delays in reporting of claims. These reserves for policy and claims liabilities are estimates and, as such, are subject to variability, which could be material in the near term. Changes to the estimates could result from future events such as receiving additional claim information, changes in judicial interpretations of contracts or significant changes in severity or frequency of claims from past trends. In general, the longer the term required for settlement of a group of claims, the more variable the estimates. The estimates are principally based on the company's historical experience. Methods of estimation have been used that the company believes produce reasonable results given current information. As additional experience and other data become available, the estimates could be revised. Any future changes in estimation would be reflected in the statement comprehensive income (loss) for the year in which the change occurred. 13
4. Insurance contracts Deferred premium acquisition costs The following is a schedule of the changes in deferred premium acquisition costs for the year: Beginning of year $ 613,338 $ 606,581 Written in year 1,163,125 1,150,583 Incurred in year (1,156,172) (1,143,826) End of year $ 620,291 $ 613,338 Reserve for policy claims and liabilities Changes in claim liabilities recorded in the statement of financial position for the years ended December 31, 2013 and 2012 and their impact on claims and adjustment expenses for the two years is as follows: Reserve, beginning of year Gross $ 688,250 $ 1,025,174 Reinsurance recoverable (224,958) (287,439) 463,292 737,735 Decrease in estimated losses and expenses, for losses occurring in prior years (289,248) (137,203) Provision for losses and expenses on claims occurring in the current year 2,358,060 2,135,804 Paid claims occurring during: 2,068,812 1,998,601 Current year events (1,869,844) (1,798,313) Prior events (105,373) (474,731) (1,975,217) (2,273,044) Reserve, end of year $ 556,887 $ 463,292 Reserve for policy claims and liabilities, end of year: Gross 680,477 688,250 Reinsurer's share (123,590) (224,958) $ 556,887 $ 463,292 The company has determined estimated settlements in the next fiscal year on the reserve for policy claims and liabilities noted above to be $489,000. This estimate was determined through the use of historical data on claims payments year over year. 14
4. Insurance contracts (continued) Reserve for policy claims and liabilities (continued) Claims development The estimation of claim development involves assessing the future behaviour of claims, taking into account the consistency of the corporation's claim handling procedures, the amount of information available, the characteristics of the line of business from which the claim arises and historical delays in reporting claims. In general, the longer the term required for settlement of a group of claims the more variable the estimates. Short-term settlement claims are those which are expected to be substantially paid within a year of being reported The table below presents the development of claims payments and the estimated total cost of claims for the years 2007 to 2013. The upper half of the table shows the cumulative amounts paid or estimated to be paid during successive years related to each claim year. The original estimates will be increased or decreased, as more information becomes known about the original claims and overall claim frequency and severity. Claims net of reinsurer's share ($'000) 2007 2008 2009 2010 2011 2012 2013 Total Net estimate of cumulative claims cost At the end year of claim $ 1,547 $ 1,574 $ 2,297 $ 2,027 $ 2,519 $ 2,135 $ 2,358 One year later 1,487 1,476 2,230 1,807 2,444 2,037 Two years later 1,450 1,479 2,216 1,757 2,406 Three years later 1,450 1,451 2,202 1,757 Four years later 1,499 1,448 2,048 Five years later 1,504 1,448 Six years later 1,504 Current estimate of cumulative claims cost 1,504 1,448 2,048 1,757 2,406 2,037 2,358 13,558 Cumulative payments 1,499 1,448 2,038 1,756 2,405 1,986 1,869 13,001 Outstanding claims 5-10 1 1 51 489 $ 557 15
4. Insurance contracts (continued) Reserve for policy claims and liabilities (continued) Reinsurance ceded Reinsurance premiums ceded and reinsurance recoveries on losses incurred are recorded as reductions of the respective income and expense accounts. Unearned premiums on business ceded and estimates of amounts recoverable from the reinsurer on reserve for policy claims and liabilities are recorded on the statement of financial position. Unearned premiums Unearned premiums on the statement of financial position consist of the unearned portions of premiums, reinsurance premiums and deferred commissions. The following is a schedule of the changes in the above for the year: Beginning of year $ 3,439,899 $ 3,197,934 Premiums written in year 6,674,741 6,446,046 Premiums earned in year (6,555,936) (6,204,081) Change in year 118,805 241,965 End of year $ 3,558,704 $ 3,439,899 5. Investments The carrying value and fair value of investments are summarized as follows: Carrying Fair Carrying Fair Value Value Value Value Held to maturity Bonds and debentures maturing within five years: Government of Canada $ 1,095,882 $ 1,146,322 $ 1,400,700 $ 1,483,521 Provincial/Municipal Governments 3,534,668 3,598,159 1,181,880 1,223,177 Canadian Corporate/Financial Institutions 1,014,398 1,047,764 1,566,242 1,621,457 Guaranteed investment certificates 300,000 300,000 - - Bonds and debentures maturing in more than five years: Government of Canada 161,368 173,630 161,619 181,424 Provincial/Municipal Governments 615,994 678,983 1,178,807 1,359,663 Canadian Corporate/Financial Institutions 299,765 298,180 101,496 110,805 7,022,075 7,243,038 5,590,744 5,980,047 Available-for-Sale Guarantee Fund - N.B.M.I.A. 66,680 66,680 66,680 66,680 16
5. Investments (Continued) Fair Value through Profit or Loss Carrying Fair Carrying Fair Value Value Value Value Equities 2,012,466 2,012,466 1,632,849 1,632,849 Preferred shares 735,329 735,329 746,449 746,449 Short term investments 1,556,890 1,556,890 2,426,790 2,426,790 4,304,685 4,304,685 4,806,088 4,806,088 The interest rates on bonds and debentures are as follows: $ 11,393,440 $ 11,614,403 $ 10,463,512 $ 10,852,815 Interest Effective Effective receivable rates rates basis (% range) (% range) Government of Canada semi-annual 3.75% to 4.5% 3.75% to 5.25% Provincial/Municipal Governments semi-annual 1.9% to 9.92% 3.50% to 9.92% Canadian Corporate/Financial Institutions semi-annual 2.94% to 4.71% 3.35% to 6.79% Guaranteed investment certificate annual 2.55% nil% 6. Investment in associate United General Insurance Corporation (United General) is owned by the four New Brunswick Mutual Insurance companies including Southeastern Mutual Insurance Company. United General writes automobile policies for these New Brunswick Mutuals. The automobile policies are sold by the company's agents and the company receives no direct benefit from these automobile policies. The investment in associate, United General Insurance Corporation (United General), includes: Voting shares $ 73,838 $ 73,838 Participating shares 2,668,788 2,668,788 Undistributed share of income 1,313,097 1,421,097 Undistributed share of income from other comprehensive income 152,614 100,804 $ 4,208,337 $ 4,264,527 At December 31, 2013, the company held approximately 31% (2012-32%) of the total equity of United General and had 25% of voting control. In the December 31, 2013 the company went to arbitration with the other shareholders of United General with regards to the interpretation of Clause 9 of the unanimous shareholders agreement. The arbitrator issued his decision on October 30, 2013. As a result, the company made an adjustment to their undistributed share of income for the 2007 to 2012 years. The result was a net reduction $131,349. This amount has been reflected in the current year s adjustment to equity income from associate. 17
6. Investment in associate (continued) Subject to the terms of a shareholder agreement, the net income or loss of United General is allocated to each shareholder annually. Historically, for each dollar of income allocated to one of the shareholders, one share of United General's participating shares is issued by way of a stock dividend. For each dollar of loss attributable to one of the shareholders, they must surrender one of their participating shares for cancellation. There have been no stock dividends or shares surrendered since 2007. As a result of the arbitration decision, the company expects the undistributed share of income to be distributed by stock dividend in the 2014 fiscal year. Under the terms of a shareholder agreement, should the company wish to withdraw from United General, it would receive proceeds equal to 80% of the book value of the company's equity in United General. If the company was required to withdraw from United General, it would receive proceeds equal to 120% of the book value of the company's equity in United General. The company's portion of United General's underwriting income is based on the auto business written by the company's agents for United General, net of the expenses relating to those premiums. The company's portion of United General's investment income and other comprehensive is based on the average net assets of United General contributed by the company. The following is a summary of the company's portion of United General's financial position and operations: Statement of financial position Assets Investments $ 5,252,655 $ 5,296,543 Due from agents, brokers and policyholders 442,676 460,948 Reserve for policy claims and liabilities recoverable from reinsurers 417,884 622,857 Other assets 331,611 340,715 Liabilities $ 6,444,826 $ 6,721,063 Reserve for policy claims and liabilities $ 1,213,721 $ 1,333,948 Unearned premiums 861,941 882,567 Other liabilities 160,827 240,021 2,236,489 2,456,536 Shareholder's equity 4,208,337 4,264,527 $ 6,444,826 $ 6,721,063 18
6. Investment in associate (continued) Statement of income Gross premiums earned $ 2,582,258 $ 2,464,532 Reinsurance costs (684,828) (816,073) Net premiums earned 1,897,430 1,648,459 Net claims incurred (1,264,478) (399,821) Commissions and other expenses (782,523) (723,568) Underwriting income (loss) (149,571) 525,070 Investment and other income 176,354 202,451 Income before income tax expense 26,783 727,521 Income tax expense (3,434) (118,104) Company's portion of annual income before adjustment 23,349 609,417 Adjustment based on arbitration decision (131,349) - Company's portion of annual income (loss) (108,000) 609,417 Beginning undistributed share of income, as previously stated 1,470,679 861,191 Prior period adjustment (faciliy risk sharing pool) (49,582) (49,511) Beginning undistributed share of income, as restated 1,421,097 811,680 Ending undistributed share of income $ 1,313,097 $ 1,421,097 19
7. Property and equipment and intangibles Property and equipment Intangibles Furniture And Computer Computer Land Building Fixtures Hardware Vehicles Signs Total Software Gross Carrying Amount Balance December 31, 2012 $ 150,000 $ 500,153 $ 105,466 $ 132,600 $ - $ 35,682 $ 923,901 $ 140,535 Additions - 17,259 2,996 9,532 - - 29,787 32,057 Disposals - - - - - - - - Balance December 31, 2013 150,000 517,412 108,462 142,132-35,682 953,688 172,592 Depreciation and impairment Balance December 31, 2012-78,816 73,950 101,648-34,106 288,520 113,824 Additions - 28,763 6,187 29,614-754 65,318 30,455 Disposals - - - - - - - - Balance December 31, 2013-107,579 80,137 131,262-34,860 353,838 144,279 Carrying amount, December 31, 2013 $ 150,000 $ 409,833 $ 28,325 $ 10,870 $ - $ 822 $ 599,850 $ 28,313 Gross Carrying Amount Balance December 31, 2011 $ 150,000 $ 497,355 $ 93,725 $ 254,410 $ 33,940 $ 35,682 $ 1,065,112 $ 246,928 Additions - 2,798 11,741 9,725 - - 24,264 20,829 Disposals - - - (131,535) (33,940) - (165,475) (127,222) Balance December 31, 2012 150,000 500,153 105,466 132,600-35,682 923,901 140,535 Depreciation and impairment Balance December 31, 2011-51,777 65,311 192,170 27,151 33,352 369,761 201,310 Additions - 27,039 8,639 41,013-754 77,445 39,736 Disposals - - - (131,535) (27,151) - (158,686) (127,222) Balance December 31, 2012-78,816 73,950 101,648-34,106 288,520 113,824 Carrying amount, December 31, 2012 $ 150,000 $ 421,337 $ 31,516 $ 30,952 $ - $ 1,576 $ 635,381 $ 26,711 The company did not record any impairment charges or reversals during the years noted above. 20
8. Investment property Land Building Total Gross Carrying Amount Balance December 31, 2012 $ 42,000 $ 97,979 $ 139,979 Additions - 11,744 11,744 Disposals - - - Balance December 31, 2013 42,000 109,723 151,723 Depreciation and impairment Balance December 31, 2012-2,449 2,449 Additions - 5,486 5,486 Disposals - - - Balance December 31, 2013-7,935 7,935 Carrying amount, December 31, 2013 $ 42,000 $ 101,788 $ 143,788 Gross Carrying Amount Balance December 31, 2011 $ - $ - $ - Additions 42,000 97,979 139,979 Disposals - - - Balance December 31, 2012 42,000 97,979 139,979 Depreciation and impairment Balance December 31, 2011 - - - Additions - 2,449 2,449 Disposals - - - Balance December 31, 2012-2,449 2,449 Carrying amount, December 31, 2012 $ 42,000 $ 95,530 $ 137,530 The fair value of the investment property is estimated at $140,000. Investment property held by the company is leased out under an operating lease on a month to month basis. 9. Accounts payable and accrued liabilities Payable to reinsurer $ 49,231 $ 50,144 Premium and fire marshall taxes payable 103,742 99,531 Other payables and accruals 309,995 291,956 $ 462,968 $ 441,631 21
10. Income taxes Provision for income taxes included on the statement 3 is comprised of the following: Current income tax expense $ (208,532) $ (53,951) Deferred income tax recovery (expense) 3,532 (48,049) $ (205,000) $ (102,000) In computing the company's taxable income there are certain items that are restricted in their deduction or are not taxable as follows: Company's income before income taxes $ 909,058 $ 1,300,946 Temporary differences 41,574 37,631 Non taxable loss (income) from associate 108,000 (609,417) Fair value adjustment for financial instruments - (334,903) Taxable dividends deductible (78,138) (58,035) Non deductible and restricted deductible expenses 25,489 11,855 Taxable income 1,005,983 348,077 Current Effective Rate 20.7 % 15.5 % Income tax expense $ 208,532 $ 53,951 Income taxes recoverable (payable) is comprised of the following: Current income taxes payable $ (154,580) $ (50,335) Deferred income taxes payable (33,852) (37,384) $ (188,432) $ (87,719) The effects of temporary differences, which give rise to the net deferred income tax assets (liabilities) reported, are as follows: Net book value of property and equipment over their undepreciated capital cost for income tax purposes $ (46,848) $ (47,639) Other temporary differences 8,680 6,665 Policy and claims liabilities reserve for accounting purposes in excess of their carrying value for income tax purposes 4,316 3,590 $ (33,852) $ (37,384) 22
11. Agents' future retirement compensation United General Insurance Corporation (United General) had a contract with their agents to compensate them on retirement. The agents of Southeastern Mutual Insurance company are also agents of United General. In the 2006 fiscal year Southeastern Mutual Insurance Company had taken on the liability owed by United General to their common agents. A payment equal to the liability had also been received from United General and is included in the assets of the company. The amount payable to the agents has been capped as at December 31, 2006, and will not change. As the company has the ability to utilize the funds paid for this retirement compensation, the amount included in the financial statements has been discounted using the average bond rate of the company as of December 31, 2006, and the difference between the retirement payment and value at that time is being accreted over the expected years to retirement of the individual agents. The ultimate liability will remain at $127,025. 12. Related party transactions Key management of the company is senior employees, officers and members of the board of directors. Key management personnel remuneration includes the following expenses: Key management remuneration $ 465,098 $ 451,109 Included in the statement of operations are the following items relating to key management: Premiums paid $ 21,731 $ 22,162 Claims incurred $ 11,572 $ 875 13. Investment and other income Interest from term deposits, bonds and debentures, net of bond amortization $ 238,919 $ 248,820 Dividends 82,775 73,087 Gain (loss) on disposal of equity investments 116,547 (255,408) Change in fair value through profit or loss financial instruments (Note 17) 430,568 428,026 Management fees on investments (27,822) (45,167) Gain on sale of property and equipment 315 3,832 Other 2,850 174 14. Contingent liabilities $ 844,152 $ 453,364 In common with the insurance industry in general, the company is subject to litigation arising in the normal course of conducting its insurance business which is taken into account in establishing the reserve for policy claims and liabilities. 23
15. Capital management The company s objectives with respect to capital management are to maintain a capital base that is structured to exceed regulatory requirements. Reinsurance is utilized to protect capital from catastrophic losses as the frequency and severity of these losses are inherently unpredictable (see Note 16). The company also maintains a required amount of general reserve. In accordance with the Insurance Act of New Brunswick this requirement at December 31, 2013 is computed as $8,830,159 (2012 - $8,274,269) and is available only to discharge obligations of the company not provided for out of its ordinary receipts. The ultimate disposition of this general reserve is at the discretion of the Lieutenant-Governor in Council. Government regulators measure the financial strength of property and casualty insurers using a minimum capital test (MCT). The regulators generally expect property and casualty companies to comply with capital adequacy requirements. This test compares a company s capital against the risk profile of the organization. The risk-based capital adequacy framework assesses the risk of assets, policy liabilities and other exposures by applying various factors. The regulator indicates that the company should produce a minimum MCT of $1,220,000 (2012 - $1,161,000). As another measure of capital adequacy, the company has established a target MCT of 450%. As at December 31, 2013 the company's, as capital calculated by the NB Insurance Act, was $9,916,000 (813% of required minimum capital, 2012-773%). 16. Risk management, reinsurance and other risks (a) Risk management Consistent with other similar entities, Southeastern Mutual Insurance Company's risk management policies are typically performed as part of the overall management of Southeastern Mutual Insurance Company's operations. Management's close involvement in operations identifies risks and variations from expectations leading to changes in risk management activities and requirements and actions. Management has not entered into hedging transactions or other derivatives to manage risk. As part of the overall management of the entity's operations, management avoids undue concentrations of risk to mitigate credit risk. The company purchases reinsurance to share part of the risks originally accepted by the company in writing the premiums. The reinsurance however does not relieve the company of its primary obligations to policyholders. The business risk of insurance resides in pricing the products, in management of investment funds, and in the estimation of claim costs. Ongoing management practices and policies of the company in underwriting, claims and investment activities control the risk exposure. 24
16. Risk management, reinsurance and other risks (continued) (b) Insurance risk Reserves for policy claims and liabilities The reserves for policy claims and liabilities and related reinsurer's share are estimates subject to variability and the variability might be material in the near term. The variability arises because all events affecting the ultimate settlement of claims may not have taken place and may not take place for some time. Variability can be caused by receipt of additional claim information, changes in judicial interpretation of contracts or significant changes in severity or frequency of claims from historical trends. The estimates are principally based on the company's historical experience. Methods of estimation are used, which the company believes produce reasonable results given current information. All changes in estimates are recorded as incurred claims in the current period. The company assists in minimizing risk of the above by diversifying risk across a large portfolio of insureds. Reinsurance and underwriting The company mitigates its insurance risk by having in place underwriting guidelines as well as reinsuring insurance contracts which limit the liability of the company to a maximum amount on any one claim. The company uses its underwriting guidelines to minimize risk by assessing individual policies, determining if the risk is within the tolerable range and then pricing the policy accordingly. The current reinsurance contracts are as follows: Property claims First $200,000 per loss is paid by the company, which limits the company's exposure in any one property claim to $200,000. In addition, the company has obtained reinsurance which limits the company's liability to $600,000 in a catastrophe. Stop loss reinsurance is also in effect which protects the company to limit the "Net Incurred Loss Ratio" to 80% of its insurance premiums. For the 2014 fiscal year the reinsurance arrangement will change for property claims to $225,000 per loss. This will limit the company's exposure in any one property claim to $225,000. In addition the company's liability in a catastrophe will be $675,000. Liability claims The company will pay 100% of all losses, up to a maximum retention of $200,000 per loss, which limits the company's exposure in any one liability claim to $200,000. For the 2014 fiscal year the reinsurance arrangement will change for liability claims to $225,000 per loss. This will limited the company's exposure in any one liability claim to $225,000. The reinsurance of insurance contracts does not relieve the company's obligation to the policyholders. The company is exposed to the risk that the reinsurer will be unable to meet its obligations. The Superintendent of Insurance also limits the company's maximum retention through its reinsurance arrangements to be the maximum of 2% of general reserve or $350,000. The company's allowed maximum retention as of December 31, 2013 would be $283,000. 25
16. Risk management, reinsurance and other risks (continued) (b) Insurance risk (continued) Insurance pricing The company is exposed to pricing risk to the extent that the company's unearned premiums are insufficient to meet related future policy cost. The company evaluates this risk on a regular basis by estimating future policy costs through extrapolation of historical loss trends. Reinsurance undertaken The company participates in programs to provide re-insurance for crop and catastrophe reinsurance. The maximum retained liability for the company in any one year is $525,000 (2012 - $312,500). For this reinsurance undertaken the company has recorded $38,578 (2012 - $29,048) of premiums included in premiums written on Statement 3. Property insurance risk In the current year the company has underwritten insurance on the two properties it owns (Note 7 and Note 8). There is a risk to the company if there is a claim under its property or liability insurance. The current maximum risk to the company is $200,000 in property insurance and $350,000 in liability insurance totaling $400,000 in total risk exposure. This maximum risk exposure takes into consideration that the company will be subject to maximum property and liability claims, however this is unlikely to occur. The company's insurance policies follow standard reinsurance arrangements as noted above. (c) Other risks Credit risks Credit risk arises from the potential that a counter party will fail to perform its obligations. The company conducts a thorough assessment of debtors prior to granting credit and actively monitors the financial health of its debtors on an on-going basis. The company is also exposed to this risk relating to its debt holdings in its investment portfolio, premiums receivable from policyholders and the reliance on reinsurers to make payment when certain loss conditions are met. The company s investment policy puts limits on the bond portfolio including portfolio composition limits, issuer type limits, bond quality limits, aggregate issuer limits, corporate sector limits and general guidelines for geographic exposure. The bond portfolio remains very high quality with all of the bonds rated "A" or better. All fixed income portfolios are measured for performance on a quarterly basis and monitored by management on a monthly basis. Reinsurance is placed with FMRP, a Canadian registered reinsurer. Management monitors the creditworthiness of FMRP by reviewing their annual financial statements and through ongoing communications. Reinsurance treaties are reviewed annually by management prior to renewal of the reinsurance contract. Accounts receivables are short-term in nature and are not subject to material credit risk. The maximum exposure to credit risk and concentration of this risk is outlined in Note 17. There have been no significant changes from the previous period in the exposure to risk or policies procedures and methods used to measure the risk. 26